Fighting Deforestation and Climate Change: REDD Financing Lessons from Brazil and Indonesia (Excerpt)

Consider the rainforests.  It is not hard to imagine how the destruction of rainforests hurts biodiversity. Second only to coral reefs, tropical rainforests are the most biologically diverse ecosystems on earth. They also support the 70 million people who live in them.

Perhaps less intuitive is the role rain forests play in climate change. Deforestation accounts for roughly 15 percent of global greenhouse emissions. This is as much as the output of all cars, trucks, and buses combined. And rainforests serve as “sinks” or storage for CO2. Reducing deforestation is critical to climate change mitigation, and one of the more cost-effective approaches. The lion’s share of these deforestation-related emissions comes from seven tropical countries, Brazil and Indonesia among them.

Pay-for-Success

REDD — Reducing Emissions from Deforestation and Forest Degradation — is a pay-for-success program designed to create economic incentives to protect forests and the carbon they contain. First introduced into the UN climate talks in 2005, by scientists and environmental advocates from Brazil and the U.S. using the term “Compensated Reductions,” REDD has evolved to include a range of innovative financing approaches to reduce emissions related to deforestation.

The motivation behind REDD is as much long-term sustainable development as it is forests per se. Among the primary drivers of growth in countries like Brazil have been the development of commodities like palm oil, soy, and beef, often through deforestation—clearing trees to raise crops and cattle. REDD’s pay-for-success design is meant to motivate less carbon-intensive production. That means improving economic output while decreasing emissions.

REDD was originally premised on the idea that forest conservation could attract significant financial resources by allowing verified reductions in emissions to generate credits that could be used for compliance in cap-and-trade programs in other countries.

With the delayed development of these compliance markets in places like the United States, the REDD framework has evolved as a kind of innovative finance development assistance, relying primarily on public sources of funds. The private capital markets have yet to be fully harnessed.

Pay-for-success is indeed an innovation in finance, even if, to date, that finance is in the form of aid.

For example, in 2008, Norway pledged up to $1 billion to Brazil for verifiable proof that deforestation had decreased—that’s the success piece. The payments are intended to make it more economically feasible and attractive for countries and farmers to conserve forests than it is to cut them down.

Payments seek to make emission mitigation cost effective for Brazil and Brazilian producers: leaving forests standing is much cheaper than investing in renewable energy or carbon capture, and cheaper still than adapting to the catastrophic effects of climate change. An ounce of prevention is worth a pound of cure.

Ounce of Prevention

“To put a complex political, economic, and scientific argument in its simplest terms,” says Mark Tercek of the Nature Conservancy, “if you can prevent pollution in the first place, then you won’t have to spend huge sums of money to clean it up later.”

REDD funds are used for implementation, monitoring and “readiness” plans – a kind of pay-for-preparedness, which is akin to prevention. As is the hallmark of pay for success, payments come after there is proof that deforestation rates have been reduced. All of this differs from traditional grant-based development assistance, which historically has not been contingent upon these kinds of performance objectives.

Rather than a mandated or uniform approach like emissions trading, the REDD movement has stimulated a number of “demonstration activities” to test ways in which countries and local landholders could be motivated to protect forests. The World Bank’s Forest Carbon Partnership Facility provides funding for the development of national strategies and capacity building for REDD, with help from organizations like Global Canopy Programme.

Perhaps most interesting are the bilateral activities emerging outside of these formal multilateral institutions. Norway, for example, a country that has become extremely wealthy in recent decades from its North Sea oil, has used some of this wealth for generous and innovative development aid generally (Norway spends more than 1 percent of GDP on aid, the highest percentage of any country) and on climate change initiatives in particular.

In 2008, Norway created its own International Climate and Forest Initiative (NICFI) to support REDD activities in countries willing to make substantial improvements in their rates of deforestation. Norway promised to provide up to $1billion for demonstrated reductions in deforestation in both Brazil and Indonesia, countries with large, valuable and disappearing rainforests. Their different experiences tell us a lot about the success of pay-for-success.

Norway pledged $1 billion for Brazil through the creation of a Brazilian Amazon Fund, payable if Brazil brought its annual rates of deforestation down below its 1996- 2005 average of approximately 19,508 square kilometers per year. The Amazon Fund would be administered through BNDES (the Banco Nacional de Desenvolvimento Econômico e Social) to finance projects that reduce deforestation and promote sustainable development more broadly in the Amazon.

Brazil was a promising partner for Norway, not simply because of the alarming rates of deforestation of the Amazon canopy. Brazil had recognized deforestation as an impediment to long-term economic development and, aimed to reduce its deforestation rate 80 percent by 2020 (versus the previous decade average).  From 2002 to 2009, Brazil increased the area of legally protected Amazon forest by 50 percent. By 2010, deforestation in the Amazon had fallen nearly 70 percent below the ten-year average (to 6,451 km2), ten years ahead of schedule.

Brazil’s economy grew 7.5 percent per year in this period, with agricultural production and profitability increasing substantially in many legally protected regions. In other words, production increased while emissions decreased. It is estimated that this reduction in deforestation reduced Brazil’s global warming pollution by nearly 1 billion tons. As a result of the demonstrated reductions in deforestation—the verification comes through satellite photos of the Amazon— Norway has now allocated the full $1 billion to the Amazon Fund. Germany and Petrobras are now also supporters. The Norway-Brazil agreement has been extended to 2021.

Lessons from Brazil

The Brazilian REDD agreements with Norway are largely considered a success, though not without qualification. Nancy Birdsall, Frances Seymour, and William Savedoff at the Center for Global Development, who have studied REDD extensively, conclude that, on balance, the Brazilian government’s efforts, supported by Norway, enhanced the legitimacy and strength of local conservation advocates, pushing the government towards greater action on deforestation and changing incentives for commodity producers when it comes to deforestation.

The fact that the Norway-Brazil deal did not ultimately hinge on market- based tradable offsets, as originally envisioned, may have been important to its early success. Brazil, like other developing countries, initially opposed the idea of offsets as they seemed to let wealthier countries off the hook—allowing them to purchase the right to pollute from developing countries rather than reduce their own emissions.

This tension between more developed and developing nations has simmered for decades. Emerging countries have challenged what they characterize as a double standard—that wealthier countries industrialized in ways that were not sustainable—and sought more autonomy in their own development today.

The REDD agreements are not without challenges or concerns. Monitoring and assessing reductions in deforestation and CO2 emissions is vital. It requires the establishment of the right baseline or “reference” levels and accurate verification with satellite imagery of progress towards measurable and predetermined objectives. The success of the program hinges on precise and reliable data evaluation.

Critics of Brazil’s REDD agreement suggest that causality is hard to prove. Indeed Brazil’s rate of deforestation had begun to decline prior to 2008; the country was already on the path to lower carbon development. It is difficult to determine whether and how much REDD motivated further reductions in deforestation.  This is important because REDD funding is meant to be additional—to spur improvements in forest management and a more sustainable development than would have occurred otherwise.

Finally, there is also concern over what economists call leakage: conserving forests in one place only to shift deforestation to another. For example, a country like Brazil might pursue REDD projects that reduce deforestation while at the same time and in other regions building hydropower dams, roads, and other infrastructure projects – often with BNDES as a lender –that can be destructive to forests and indigenous people. Indeed, to be durable and effective, REDD programs should be integrated into a government’s broader development strategy.

To help address these concerns, most international REDD efforts, including Norway’s Amazon Fund, the World Bank FCPF, and the UN’s own REDD+ framework, have moved to a “jurisdictional” approach – measuring (and rewarding) performance at the level of a major jurisdiction like a state or country.

REDD raises questions about how pay-for-success works in practice, its advantages, and its limitations. One of the virtues of pay-for-success, whether it is used to tackle climate change or a broad range of other social and economic challenges, is that it is hands off—it lets local governments and communities design policies and practices that they believe will best achieve results. The autonomy that pay-for-success fosters is a hallmark of innovative finance.

However, this arms-length arrangement means there is little way to determine whether local governments are acting in good faith—for example, that they are working equitably with forest-dependent communities who lack sufficient land, resources, or other rights. So while pay-for-success is meant to align incentives to improve governance, it is no guarantee.

Non-Pay for Non-Performance

Which brings us to the case of Indonesia. In 2009, Indonesia became one of the first developing countries to set targets for reducing its greenhouse gas emissions—much of which came from deforestation.  The country’s leading export commodities, like palm oil and timber for pulp and paper, are produced by burning down large swaths of forestland – and the thick haze these forest fires produce pose a significant health hazard to Indonesians.

In 2010, Indonesia and Norway entered into a REDD pay-for-success arrangement, in which Indonesia agreed to a broad set of policies to address deforestation problems, including a moratorium on new licenses for forest exploitation.Yet despite these commitments, Indonesia’s deforestation—both legal and illegal—and related emissions increased through 2012. Accordingly, Norway did not release any payments. (There is some recent evidence that Indonesia’s deforestation and greenhouse gas emissions have improved slightly, but still far short of its target to reduce emissions by 26 to 41 percent by 2020.) The current government in Indonesia, elected in late 2014, is working hard to improve forest management (and the prospect of funding for these reductions from Norway).

Critics of REDD cite the lack of enforcement—the flipside of laissez-faire autonomy—as a shortcoming of pay-for-success. There is no payment for non-compliance, but neither are there proactive fines or penalties. Some argue that this amounts to “non-payment for non-performance” or, worse still, “sitting back and waiting for what’s left of Indonesia’s forests to go up in smoke.”

Supply and demand

Despite these real governance shortcomings, most consider REDD a promising way to give countries committed to sustainable development more resources. And yet even if we consider the case of REDD in Brazil as an encouraging and successful model of development assistance Norway’s $1 billion is not enough. In some ways, this proves REDD’s success: projected ‘supply’ of potential emissions reductions from REDD and similar initiatives could be as many as 39 times larger than total projected ‘demand’ from investors and donors.

Where will we find the capital to bring REDD to scale?

The World Bank and UN estimate that investments needed for climate change mitigation and adaptation far exceed all overseas development assistance.  This suggests, a need for broader carbon markets. Although some developing countries did not initially embrace offsets and tradable emission credits, many now see direct access to the capital markets as a relatively autonomous way to harness funds for climate change mitigation and adaptation, certainly a path to scale. A number of nascent initiatives—and a promising area of exploration for innovative finance—look to connect REDD to the broader capital markets.

One such proposal considers how an endowment, to create a kind of global sovereign wealth fund to stem deforestation. The annual payout or returns from the endowment would go to REDD efforts.

Another idea is to link jurisdictional REDD efforts in Brazil and elsewhere to compliance carbon markets. That includes the cap-and-trade program already operating in California as well as the global market-based measure for international aviation, adopted recently by the International Civil Aviation Organization and set to start in 2021. Solutions to global warming, the thinking goes, require global reductions in CO2 – regardless of where those reductions are achieved.

Looking to take advantage of these nascent compliance markets, the Environmental Defense Fund and Encourage Capital, an investment firm focused on financial, social and environmental returns, are developing a REDD Accelerator Fund.

Through the fund, companies with compliance obligations in California, or airlines flying on international routes, could purchase jurisdictional REDD credits now that could be used to meet compliance obligations in the future – if those carbon markets decide to allow REDD credits into their programs.

A potential initial source of supply for the REDD Accelerator Fund would be Acre, a state in Brazil that has slowed its rate of deforestation by 70 percent since 2005. Acre hopes to protect the 87 percent of its surface that is still forested, an area the size of New York State.  The fund would be capitalized initially through an innovative “blend” of sources: corporations seeking compliance offsets, philanthropies providing grants and first-loss guarantees, and impact investors.

The fund aims to catalyze compliance markets for REDD credits, by signaling to policy makers that there are both investors ready to purchase offset credits (‘demand’) and projects that lend themselves to carbon reduction (‘supply’). At the same time, the fund would provide “bridge” financing that could support the development of jurisdictional REDD programs in advance of carbon compliance markets coming fully online.

Disclosure

Adapted from CAPITAL AND THE COMMON GOOD: How Innovative Finance is Tackling the World’s Most Urgent Problems, by Georgia Levenson Keohane (copyright © 2016) with permission from Columbia University Press.  All rights reserved.

The author is married to Nat Keohane, vice president for international climate at EDF and one of the leaders of the REDD Accelerator Fund effort with Encourage capital.

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